With several measures recently introduced to improve Luxembourg's competitiveness as a financial centre, are corporate taxpayers benefiting? Thierry Lesage reports

Luxembourg's tax system is constantly evolving, with the aim of improving the country's competitiveness in general and its financial centre in particular.

In May 2008, Luxembourg's Prime Minister, Jean-Claude Juncker, announced several measures, the major change being the abolition of capital duty as of 1 January, 2009. While capital duty had already been reduced from 1% to 0.5% from the beginning of this year and was due to be abolished as from 2010, the Government decided to speed up the abolition in order to make Luxembourg still more attractive for foreign investments.

Besides, the aggregate rate of corporate income tax and municipal business tax should progressively be reduced from a maximum of 29.63% (Luxembourg City rate) to 25.5%. No details have yet been announced on the proposed timing but this decrease is likely to spread over at least two years. The tax base is also likely to be widened slightly in order to limit the impact for the budget.

A law of 21 December, 2007 has introduced a new tax regime (effective since 1 January, 2008) in the field of intellectual property (IP) with the intention of attracting the management of IP rights and to encourage the development of research and innovative activities in the country.

Article 50 bis of the Luxembourg income tax law – introduced by the above-mentioned law – provides for an exemption of 80% of the net positive income generated by the use or the right to use IP rights (copyrights on computer software, patents, trademarks, designs, models). The net positive income is defined as the gross income reduced by the amount of expenses directly related to income, including annual amortization and any depreciation. This exemption leads to an effective tax rate of maximum 5.93% (20% x 29.63%) in Luxembourg City.

The taxpayer who has himself created a patent and uses it in the course of his business is also entitled to a deduction equal to 80% of the net positive income (as described above) which he would have derived from, should he have conceded the use of this right to a third party. The introduction of such a notional deduction is very beneficial to those taxpayers concerned, although it should be noted that the benefit of this provision is limited to patents.

Capital gains deriving from the disposal of above-mentioned rights are also exempt up to 80%. However, the capital gain exemption does not apply to the extent of expenses directly connected with the IP (including amortization and depreciation) that have reduced the taxable base during the year of the disposal or any previous year.

To benefit from such a tax regime:

• the right has to be acquired or established after 31 December, 2007;
• lexpenses connected with the IP must be written as an asset in the balance sheet and added to the taxable base during the first year for which this special regime is used, to the extent that for the given year, expenses connected with the IP have exceeded related income; and
• the IP may not have been acquired from an affiliate company (i.e. mostly a company holding a direct participation of a least 10% of the share capital of the Luxembourg recipient or a company directly held for at least 10% by the Luxembourg recipient.)

In addition to the recent measures as described above, Luxembourg offers an extended tax treaty network with more than 50 treaties currently in force.

In view of a constant expansion of this network, Luxembourg has entered into negotiations – which have reached a more or less advanced stage – or has signed treaties with more than 20 countries including India, Qatar, Cyprus, Bahrain and the United Arab Emirates.

In this context, a first-time double tax treaty between Luxembourg and Hong Kong was signed on 2 November, 2007. Subject to the ratification procedures (in progress) on both sides, the treaty will retroactively apply as from 1 April, 2008 with respect to Hong Kong taxes and as from 1 January, 2008 with respect to Luxembourg taxes.

This treaty globally follows the Organisation for Economic Co-operation and Development (OECD) Model Convention, adapted to take into account local specificities and the fact that Hong Kong is a special administrative region of the Popular Republic of China and not an independent state. This treaty aims at providing a very competitive tax frame and investment opportunities to enterprises of both states.

A maximum 10% withholding tax applies on dividends, reduced however to 0% if the beneficiary is a company which holds at least 10% in the capital of the distributing company or has acquired the distributing company for an acquisition cost of at least E1.2m (£940,332) (no holding period requirement applies).

As for interest, exclusive taxation in the country of residence of the beneficial owner has been chosen. Concerning royalties, a maximum withholding tax rate of 3% has been agreed, which is at the time of the signature of this treaty the most favourable rate obtained compared to double tax treaties negotiated by other countries with Hong Kong.

One should note that Hong Kong so far has very few tax treaties with European countries. Notably, a treaty between Belgium and Hong Kong was signed in December 2003 and potentially eliminates withholding tax on Belgian-source dividends. However, the Hong Kong-Luxembourg treaty provides relief under more favourable conditions than the Belgium-Hong Kong treaty.

Indirect taxes

Several measures have been recently introduced in order to improve the Luxembourg VAT system.

Luxembourg's position as a leading e-commerce centre has been reinforced since the scope of the 3% VAT rate was extended to the broadcasting and television services (both the content and its mere transmission), regardless of the type of technology used for the transmission.

For instance, electronic services provided by companies established in Luxembourg, to individuals established in the European Community will be taxable in Luxembourg only at a 15% VAT rate, the lowest rate in the European Union (EU).

Further, an optional system of tax representation for VAT purposes was introduced in order to facilitate the development of logistic activities.

Foreign traders, being neither established nor identified for VAT purposes in Luxembourg, may, as from 1 January, 2008, either register directly or appoint a third party in Luxembourg to carry out the necessary VAT formalities and to pay the VAT due in Luxembourg on his behalf.

The VAT representation is subordinated to a certification procedure and limited to imports of non-EU goods to Luxembourg and services performed on these goods in Luxembourg after import.

The VAT representation will cover only the operations for which the VAT representative has explicitly accepted to represent the foreign trader.

Thierry Lesage is a tax partner at Arendt & Medernach in Luxembourg.